FOUR ASSUMPTIONS OF CAPITALISM

In one of my college classes that focused on the interaction between business, society and government, we discussed a set of principles that was referred to as “the 5 assumptions of capitalism”. Here's a link to the powerpoint document from the class just to prove I'm not making this up (it's the 16^th slide).

www.suu.edu/faculty/johnsonr/4200/CLASS2.PPT 

Capitalism is touted as the most efficient economic system.  Theoretically, when one or more of these 5 elements are missing or are interfered with, the economic system reaches a lower level of efficiency, and becomes something less than pure, unadulterated capitalism. I'll be addressing only four of the assumptions – I've been out of school for several years, and I don't recall much about the fifth assumption, which was referred to as “Institutions Functioning as Designed”.

On face value, these are common sense assumptions, but when you consider them carefully, I think they raise some interesting questions as to whether common practices, policies, and ways of thinking that we tend to accept as part of a free market concept are in fact taking us further away from capitalism. 

Also, the explanations of these four assumptions are my own words according to my own understanding, so please take the following with a grain of salt, and feel free to tell me where I've erred.

Assumption #1- The rational consumer. The inherent assumption here is that consumers will act in their own best interest, will not pay more than they need to for a product or service, will prioritize necessities above frivolous or unnecessary purchases, etc.

Assumption #2 - Full and accurate information. Buyers and sellers will both have access to basic, important information relevant to the transaction at hand. This is closely related to the first assumption, because how can a consumer make rational decisions if they are unaware of important information pertaining to the product or service they are considering?

Assumption #3 - Costs and benefits are fully contained within the transaction. Whenever the costs of a transaction are borne by someone other than the buyer and the seller, and whenever the benefits of a transaction are enjoyed by those who are not party to the transaction or the intended recipients of the benefits of the transaction, then the transaction results in a less efficient allocation of resources. In its most simplistic form, this assumption states that theft will decrease the efficiency of capitalism.

Assumption #4 – Income is distributed fairly. The income any person receives is a direct result of the value of they have created. Thus the wealth any one of us accumulates (or fails to accumulate) should be basically a reflection of our own choices, the career path we choose to pursue, the level of effort we put forth, the risks we are willing to take, etc.

Now that I've briefly explained these four assumptions of capitalism, I'll cite a few examples of how our society fails to meet these basic requirements, resulting in a less than optimum economic system than would be attainable under true capitalism.

Marketing/Advertising/Sales

In theory, advertising fulfills an important function – making full and accurate information available to potential buyers. In practice, advertising tends to focus heavily on the positive aspects of a product or service, while downplaying or even failing to address the negative aspects. 

A prime example would be the pharmaceutical commercials that spend the first 30 seconds telling you how the new drug will cure your depression or restore your balding hair, and showing you images of happy, beautiful people. And then they cram ten different disclaimers in the last ten seconds about how possible side effects include sudden onset of schizophrenia, nasal spasms, and PTRF (Premature Termination of Respiratory Functions). 

This is actually a good example of how government intervention can play an essential role in maintaining capitalist ideals. Without government regulation, would advertisements even include any of those disclaimers?  Would there be any chance that consumers of such prescription drugs would be making rational decisions based on accurate information?

Looking at other examples, it's apparent that the purpose of advertising is often not to present the all the facts, but to only present some of the facts from a skewed perspective. 

A commercial can tout a small car as having the government's highest crash test rating, but omit the fact that there are five comparable small cars built by other companies, all five of which also have the highest crash test rating, are less expensive, get better mileage and have better warranties.

Celebrity endorsements, humor and special effects are used to make commercials more appealing. Companies spend hundreds of millions of dollars each year on these strategies, but these strategies don’t add any value to the products and services being touted, nor do they lead to better informed consumers. And these strategies work. Sometimes they are alarmingly effective, leading to very irrational purchasing behavior, like people living in abject poverty who buy $120 shoes endorsed by the all-star basketball players.

Inheritance Taxes

If I were asked to define “royalty” in the most simple, basic terms, I'd say it is “people who come into a position of extreme wealth and power by virtue of the fact that they were born to extremely wealthy and powerful parents.”

Is there anything less American than the notion of a monarchy? If we allocate wealth to people based on lineage, rather than what they themselves have done to earn it, is that compatible with capitalism? Yet, that is what we allow to happen on a regular basis. 

I'll refer to a study that was conducted in 1997 that analyzed how the 400 wealthiest individuals and 50 wealthiest families on the Forbes 400 list made their fortunes. The study concluded:

·         42% were “born on home plate”, meaning their inheritances alone would have put them on the Forbes 400 list.

·         6% were “born on third base”, meaning they inherited substantial wealth in excess of $50 million or a large and prosperous company, and grew their initial fortune into membership in the Forbes 400.

·         7% were “born on second base”, meaning they inherited a medium-sized business or wealth of more than $1million, or received substantial start-up capital for a business from a family member.

·         14% were “born on first base”, meaning they came from an upper class background, and received substantial inheritance or start-up capital from family worth less than $1 million. (Due to the conservative nature of the rankings, it is probable that some of the people in this category should have actually been assigned to 2^nd or 3^rd base).

·         31% were “born in the batter's box”, meaning their parents did not have great wealth or own a business with more than a few employees.

The conclusion of the study is, “The data, then, do not support the assumption that the United States is a true meritocracy where the most able rise to their rightful positions. Nor do they defend the contention that the United States is structured so that authentic equality of opportunity prevails. Inheritances undermine the achievement-reward equation.”

http://www.faireconomy.org/press_room/1997/born_on_third_base_sources_of_wealth_of_1997_forbes_400

I'll leave it at that for now, but I'd like to know what you guys think. Do you agree or disagree with the “four assumptions of capitalism” as I've presented them here? Are any of my conclusions somehow flawed? If you agree with assumption #3, then wouldn't you at least agree that “cap-and-trade” proposals are based upon solid capitalist principles? Do those four principles bring to mind any other flaws in the way we do things?